ECONOMIC ANNALS, Volume LXII, No. 215 / October – December 2017 UDC: 3.33 ISSN: 0013-3264
https://doi.org/10.2298/EKA1715169I
Mirjana Ilić* Veselin Avdalović** Milica Obadović***
SURVEY OF THE READINESS OF INSURANCE COMPANIES IN SERBIA FOR SOLVENCY II
ABSTRACT: The main objective of this Solvency II regime and the adjustment of paper is to analyse the readiness of the larg- current legislation to the European stan- est insurance companies operating in Ser- dard, and whether the insurance sector in bia to implement the upcoming Solvency Serbia will manage to overcome the obsta- II regulation. The survey was conducted cles and adopt the policies and procedures in 2014 using a questionnaire comprising prescribed by Solvency II when required. 30 questions. It was sent to the seven big- Adopting the European Solvency II regula- gest companies operating in Serbia during tion means a complete reorganization of the research, which cover 80% of the mar- the insurance sector in Serbia, which has ket. The questionnaire covered both the not been sufficiently surveyed, and never in organizational and technical profile of the this manner. insurance companies. The survey helped to understand the benefits and problems KEY WORDS: Solvency II, Insurance, for the domestic insurance market that Regulations, Serbia would result from the introduction of the
JEL CLASSIFICATION: G22, G28
* The College of Tourism, Belgrade, [email protected] ** Faculty of Economics, University of Niš *** Insurance company DDOR Novi Sad
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I. INTRODUCTION
Surveys conducted by the European Commission and global audit firms, (see paragraph 4) have found that many companies operating in the EU insurance sector were not fully prepared to meet the requirements of European Union regulation. The fact that the Serbian insurance sector is much less developed than the EU insurance sector indicates that the adoption of European regulations will be difficult, due to the small size and scope of local insurance companies and their unpreparedness to adopt new working methods. Given that assets and liabilities will be measured according to market principles and that the market will be reflected in the balance sheet, fulfilling the requirements of the Solvency II regulation requires a long period of time, as well as a large amount of money, which most companies in Serbia are not prepared to invest.
In Serbia, insurance company solvency is still regulated by the Decision on Capital Adequacy of Insurance/Reinsurance Undertakings. This Decision requires insurers to calculate separate solvency margins for life and non-life insurance. The solvency margin should allow continuous control of the required capital and the insurer’s risk exposure. The Decision on Capital Adequacy of Insurance/Reinsurance Undertakings only takes into account exposure to insurance risk. This means that the solvency margin is calculated based only on the liabilities of the insurance company, and interest rate risk and other market risks are not adequately included in the calculation.
Solvency II will introduce more complex requirements for capital insurance companies than those currently in operation. It will change the way that insurance companies in Serbia manage risk, because they will be obliged to determine required capital (solvency capital requirement-SCR and minimum capital requirement-MCR) on the basis of the risk profile of their undertakings and the way in which such risks are managed. The required capital is calculated either by using a standard formula that is regulated at the EU level or by the development of an internal model that is designed to reflect the insurer’s unique risk profile. For Serbian insurance companies this means using completely new knowledge, methodologies, data, and calculations, and will completely change the way in which insurance companies’ balance sheets are constructed.
A number of institutions are involved in setting Solvency II standards. The most important is the European Insurance and Occupational Pensions Authority (EIOPA). The European Commission has requested that the Committee of
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European Insurance and Occupational Pensions Supervisors (CEIOPS) manage the entire process. Among other things, CEIOPS consults with all market participants on future solvency rules. CEIOPS also performs quantitative impact studies (QIS) to test the proposed rules. The QIS exercises are essential to ensure that Solvency II is designed in the most appropriate manner, with sufficient evidence of the impact the proposed regime will have. To date, five QIS have been conducted. QIS5 was the fifth and probably the last fully comprehensive exercise to cover all 30 EEA countries. Its aim was to obtain detailed information on the proposals’ quantitative impact on insurers’ and reinsurers’ solvency balance sheets, and to check that the proposals are aligned with the principles and calibration targets set out in the Solvency II Framework Directive. The intention of the study was also to encourage insurance companies undertakings and national supervisors to prepare for the introduction of Solvency II and to identify areas where further preparatory work was required, and to provide a starting point for an ongoing dialogue between supervisors and the industry in the move towards Solvency II implementation. Finally, it also allowed the EIOPA to assess the feasibility and complexity of the proposals (EIOPA 2011).
Serbia has never participated in any QIS, and there are no studies that show where Serbian insurers stand in the matter of Solvency II. As Solvency II will be implemented in Serbia after joining the European Union, the survey presented in this paper was conducted to provide insight into how the Serbian insurance market might respond to the introduction of the Solvency II Directive and how it will adjust to the new policies and procedures, and to identify those areas that pose major challenges. The survey respondents were asked for their opinion on the impact that the adoption of Solvency II regulation will have both on their business as an individual insurance company and on the structure of the Serbian insurance sector as a whole.
The intention of this paper is not to draw final conclusions. Each company has to develop its own business model to suit its own way of operating; there is no single formula for the successful implementation of Solvency II.
2. LITERATURE REVIEW
The impact of Solvency II on the operations of EU insurance companies is extensively covered in the literature, specifically in relation to corporate business processes, sectors, risk management methods, capital, costs, profits,
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company rating, company operations, and impact on the insurance sector and the EU economy. A lot of practical research and many empirical surveys have investigated the changes that Solvency II will have on insurance practices and have identified the preparedness of insurers.
Argyrou, Hanspal, and Orros (2012) examine embedding Solvency II into ‘business as usual’ for general insurance and come to the general conclusion that there is no ‘one size fits all’ solution, and that much depends on the corporate culture, the quality of the senior management team, and the available resources. Bragt, Steehouwer and Waalwijk (2010) investigate the impact of Solvency II guidelines on the risk/return trade-off for life insurance companies. Rossum (2004) analyses the potential harm of increasing regulation in the insurance sector. Al-Darwish (2011) investigates how Basel III and Solvency II improve the stability of the opaque network of financial exposures that connect complex financial institutions and the contribution of these connections to financial deepening and greater savings from allocation efficiency, and how they could also have unintended consequences for the cost of capital, funding patterns, interconnectedness, and risk migration. Stoyanova and Gründl (2014) study whether the new European regulation standards will constitute a driver for mergers and acquisitions in the non-life insurance sector. Höring (2013) compares the required market risk capital of the Solvency II standard model with Standard & Poor's rating model for a fictitious but representative Europe- based life insurer, in order to discover whether the new regulatory capital requirements for market risk are a binding constraint on European insurers. Solís and Alcaide (2014) analyse the application of the Solvency II EU Directive to the Spanish life insurance industry.
Most of the surveys on the readiness of insurance companies to implement Solvency II across EU countries were made by the ‘Big Four’ professional services firms Ernst & Young (EY), Deloitte Touche, PricewaterhouseCoopers (PwC), and KPMG, only a few of which are mentioned in this paper.
In 2010 Deloitte reported on the preparedness for Solvency II of 61 insurers operating in the UK and their attitudes towards it, based on information obtained from a questionnaire. Deloitte conducted another survey in 2012 covering 60 insurers operating in the UK to identify developments in insurers’ approaches to Solvency II and to highlight the financial and business impact caused by delaying full implementation. In August and September 2013 Deloitte surveyed 293 global insurers to investigate the views of insurance companies on
172 SURVEY OF THE READINESS OF INSURANCE COMPANIES IN SERBIA FOR SOLVENCY II the intricacies of the International Financial Reporting Standards (IFRS) and their level of preparation for implementation. To discover how the financial services industry was responding to challenges posed by the global financial crisis and subsequent market and regulatory developments, in 2013 Deloitte presented a global risk management survey assessing the state of risk management in the global financial services industry. The findings are based upon the responses of 86 financial institutions from around the world. Concerning the readiness of European Insurers regarding Pillar 31, Deloitte conducted a survey in 2015 that concluded that while 60% of firms were ‘on track’ with their preparatory measures, less than 20% were close to achieving the optimal level of operational readiness, suggesting that significant work remained. The last survey Deloitte carried out before Solvency II commenced in January 2016 was a Capital Management Survey, which focuses on capital management organization and governance, changes in the capital management landscape, capital management metrics and modelling, and the strategic capital management decision process, as insurers’ solvency capital requirements are directly impacted by their investment strategies and their respective balance sheets will be sensitive to interest rate volatility when transiting to the Solvency II regime.
In the fall of 2013, EY conducted a Pan-European survey, which is an update of its 2012 survey. This very large survey is the most comprehensive in the industry, spanning 20 countries, with participants from more than 170 insurance companies. The participating companies expressed their views on current topics relating to Solvency II and gave a self-assessment of where they stood on implementation readiness for Pillar 1, Pillar 2, and Pillar 3.
In the second quarter of 2012, KPMG carried out a follow up to their initial 2010 survey to assess the state of readiness of insurance companies in Central and Eastern Europe for implementing Solvency II. KPMG also conducted the first Own Risk and Solvency Assessment - ORSA survey in Switzerland, with the aim of evaluating the impact of the new Swiss ORSA requirements. Focusing on risk governance, own solvency calculation, preparedness for and benefits and challenges of ORSA, the goal was to obtain a picture of the state of the insurance industry in Switzerland and to test the reaction of the market to the new Swiss
1 Three pillars are prescribed by the Solvency II regulation. Pillar 1 consists of the quantitative requirements (for example, the amount of capital an insurer should hold). Pillar 2 sets out requirements for the governance and risk management of insurers, as well as for the effective supervision of insurers. Pillar 3 focuses on disclosure and transparency requirements.
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Financial Market Supervisory Authority FINMA guidance. Twenty-one Swiss- based companies across Life Insurance, Health Insurance, P&C, and reinsurance participated in the survey. In 2015 a KPMG disclosures survey covered 16 European insurance groups across the UK, France, Germany, Italy, and Switzerland. The survey sought insight as to the challenges for firms regarding how and what they would communicate to investors once in a Solvency II world.
In 2010, PwC published a report presenting the findings of a survey that looked at European insurers’ readiness for implementation. The survey’s aim was to provide a benchmark against which insurers could compare their own progress. In order to evaluate the capital of material risks, in 2014 PwC conducted a Solvency II Risk Capital Survey, drawing on interviews with key members of Solvency II programmes in 16 UK companies. The report aimed to help insurers compare their methodologies and assumptions with those of their industry peers.
3. DATA AND METHODOLOGY
This quantitative research is based on responses from insurance companies operating in Serbia. The survey was conducted using a questionnaire comprising 30 questions. The questions concerned both the organizational and technical profiles of the insurance companies, and the questionnaire was sent to the top management of the largest insurance companies operating in the Republic of Serbia. The main goal was to gain through anonymous research an impartial insight into the true state of readiness of the Serbian insurance sector for the implementation of the Solvency II Directive. The results were treated confidentially and presented in an anonymous format.
When the research was conducted in 2014 the insurance sector in Serbia comprised 24 insurance and reinsurance companies. The National Bank of Serbia classifies insurance companies in three groups according to their share in the total premium (Serbian Insurance Sector Report for the third trimester of 2013). The first group comprises two companies with a share in the total premium of over 15%, the second group comprises five companies with a share under 15%, and the third comprises 17 companies with a less than 3% share. According to this report, the two largest companies in the first group cover 48.5% of the market; the five companies from the second group cover 34.5%, and the other 17 companies cover 17%. Answers were obtained from 78% of the
174 SURVEY OF THE READINESS OF INSURANCE COMPANIES IN SERBIA FOR SOLVENCY II market: the two companies in the first group, i.e., 48.5% of the market; four companies from the second group, 28.8% of the market; and one company from the third group, 0.68% of the market (see Figure 1).
The two types of questions concern organizational issues and technical profiles. The first type of question relates to the major changes that insurers expect upon implementing the Directive; the second type considers changes that have already occurred in work practice, organization, and personnel in anticipation of entry into Solvency II in Europe and Serbia.
Figure I: Total number of insurance companies operating in Serbia during the survey and number of participating companies, sorted according to share in total premium Group 1 Group 2 Group 3 Total % of % of % of No. of market No. of market - No. of market insurance share in insurance share in insurance share in companies total companies total companies total premium premium premium Insurance companies 2 48.5% 5 34.5% 17 17% 100% operating in Serbia Insurance companies 2 48.5% 4 28.8% 1 0.68% 77.98% participating in survey Source: Authors’ calculation
The participants were asked to disclose their adopted approach and to describe the progress they had made towards implementation of Solvency II. They were also asked to consider the areas in which the Directive could contribute to increasing value and what were its key challenges.
Empirical results obtained from the questionnaire were analysed by descriptive statistical analysis and presented in the form of figures and charts.
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4. EMPIRICAL RESULTS
Answers obtained from the questionnaire are summarized and presented in the form of conclusions according to the main areas of analysis. All the questions are given in the Appendix. Due to their large number, only some are presented below in question–answer form as figures. Some answers proposed in the questionnaire received no response and therefore only appear in the index.
Preparedness for the introduction of the Directive Almost a third of insurance companies in Serbia have not commenced preparations for the Solvency II project. Half of the insurance market has begun preparations, while only 4% has specifically considered the strategic impact that the regulation will have. Of the companies operating in Serbia, none has yet progressed sufficiently to cover all three pillars prescribed by the Solvency II regulation. Many companies expressed doubt that the Serbian insurance market will be able to comply with Solvency II regulation when required (see Figure II).
Figure 2: “Have you started preparations for the implementation of Solvency II?”
Source: Authors’ calculation
Key factors in the implementation of the regulation Insurance companies in Serbia recognize the key factors in the implementation of Solvency II regulation to be data quality and availability, senior management understanding the regulation, and the managing board’s commitment. Supervisors who will lead insurance companies through the process of
176 SURVEY OF THE READINESS OF INSURANCE COMPANIES IN SERBIA FOR SOLVENCY II implementing the regulation and budget and cost control are also considered very important factors in the implementation process, and a large segment of the market paid attention to precisely these factors (see Figure 3).
On the other hand, cooperation between different functions, technology, and project management are not considered essential for implementing the regulation. This indicates that insurance companies believe they will not face serious difficulties in carrying out internal reorganization and introducing technology in the process of implementing Solvency II regulation.
Processes and tools for regulation compliance Only a third of respondents are very sure that their existing processes and tools will be adequate to meet the requirements of the Directive. One-fifth of the respondents or 21%, do not think that their existing tools and processes are in accordance with the requirements of the Directive, while as many as 50% of respondents expressed concern that they will be able to continue doing business as usual when the Directive comes into force.
Impact of the regulation on company operations There is no doubt that insurers recognize the positive potential of the Solvency II project in all areas of business and that a positive impact is considered more likely than a negative one. The maximum positive impact is expected in relation to the management information required to make strategic decisions. Insurers also expect Solvency II to assist them in the capital management aspect, both at the entire company level and at the level of business units, which will produce savings in capital and thereby an increase in company profits (see Figure 4).
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Figure 3: “Please rank three key factors for implementing the Regulation”
Source: Authors’ calculation
Change drivers All key company functions will be involved in the harmonization of operations with Solvency II regulation, given the comprehensive nature of Solvency II. The Solvency II project clearly emphasizes the risk sector as the main driver of change, indicating that it is at a higher level with regard to appointment of functions and that its management structure is more developed. In addition to the risk sector, the main process drivers are the managing board and the actuarial function (see Figure 5).
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Figure 4: “In your opinion, in which of the following areas of your company’s business will Solvency II have the greatest strategic impact?”
Source: Authors’ calculation
Figure 5: Overview of main company functions as drivers of change
Source: Authors’ calculation
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Employee training A fifth of the market has not yet begun employee training for the new work methods that the regulation will introduce. Most companies train their employees internally, while a few companies send their employees to seminars, workshops, and other external forms of training (see Figure 6). Serbia has enough skilled internal staff in the actuarial sector, risk management, and finance to fulfil the requirements of Solvency II regulation, but most companies will have to engage external IT staff because they do not have sufficient internal staff to implement Solvency II regulation in this segment.
Figure 6: “Have you started employee education and, if yes, in which way?”
Source: Authors’ calculation
Own resources vs. group resources Only Serbian companies (in terms of ownership) will implement the regulation using their own resources; companies that are part of a group will take advantage of the parent company’s support in terms of specific skills, already developed models, and financial assistance. Own resources will be most useful in promoting and developing risk management, market assessment of insurance liabilities, data collection and documentation, and market reporting according to Pillar III.
Risks Solvency II requires insurance companies to analyse the risks they face across all company operations and thus to determine the appropriate level of capital to
180 SURVEY OF THE READINESS OF INSURANCE COMPANIES IN SERBIA FOR SOLVENCY II hold. Accordingly, all respondents believe that new risk mitigation techniques will be introduced in their business. However, no one has yet developed an implementation plan (see Figure 7).
Solvency II raises the stakes even further by requiring insurers to develop a framework for systematic risk management that allows for a proper understanding of risk, control, and integrated decision-making. Most board members understand the concept of an effective risk management framework. However, they may have less understanding of what this means in practice, including the manner in which the framework should be structured and managed and the impact it will have on their business.
Figure 7: “Will you introduce new risk mitigation techniques in your business and do you know how you will do it?”
Source: Authors’ calculation
Business benefits. Since the introduction of the regulation, insurers’ expectations in terms of business benefits are mainly positive. Almost a third of the market expects significant tangible business benefits from the introduction of Solvency II, while 9% of the market expects some tangible business benefits. One-fifth of the insurance market in Serbia expects business benefits from the introduction of legislation but cannot specify them. Seventeen per cent of the insurance market does not believe that the introduction of the regulation will bring them any business benefits other then compliance with the regulation (see Figure 8).
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Figure 8: “What are your expectations of the introduction of Solvency II in terms of business benefits?”
Source: Authors’ calculation
Operating expenses. Regardless of the extent of business benefits gained, an increase in operating expenses is expected as a result of introducing Solvency II regulation. These expenses are mostly in IT sector infrastructure and the implementation of risk and solvency self-assessment. Management restructuring is also considered a major cost driver when implementing Solvency II. Engagement of experts and education of employees feature as the next expenses required when implementing Solvency II, as well as internal and external reporting and acceptance of the enterprise risk management programme (ERM)(see Figure 9).
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Figure 9: “Where are operating expenses most located?”
Standard formula vs. internal model Only 3% of respondents prefer a full internal model, while the rest are divided between using a partial internal model and the standard formula. The main criterion for selecting the right model to calculate capital adequacy is the cost of its development (See Figure 10).
Figure 10: “Do you intend to use a standard formula, an internal model, or a partial internal model?”
50% 40% 30% 20% 10% 0% Full internal model Partial internal model Standard formula
Source: Authors calculation
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Challenges The biggest problems for Serbian insurers are changes that Solvency II will introduce in the entire business process, risk management, IT system development, capital modelling, and information disclosure, i.e., reporting under Pillar 3. Thus, almost all of the changes resulting from Solvency II regulation are considered to be challenges (See Figure 11).
Figure 11: “What do you consider as the challenges to implementation?”
Development of new…
Insuracne ‐ risk…
IT sistems – sistem …
Finance ‐ data disclosure
Finance – capital …
Actuarial – build, … No answer
Actuarial – standard … Very high challenges
Risk management ‐… Significant challenges No challenges Lack of understanding…
Internal audit
Cost of compliance
Redesign of business…
Board engagement
0% 20% 40% 60% 80%
Source: Authors calculation
Trusting supervision Most of the companies responded to the question “How confident you are that the supervision process will have sufficient resources to validate and approve the internal models you want to use when Solvency II comes into being?” by answering that they have no confidence in supervisors, i.e., whether the
184 SURVEY OF THE READINESS OF INSURANCE COMPANIES IN SERBIA FOR SOLVENCY II supervision process is up to the task of approving the developed internal models. This includes both making sure internal models achieve adequate quality standards and supervisors having the ability to review and approve these models. However, 30% of the insurers believe that the supervision process will have the necessary resources. Only the future will show whether this is true, and the fact is that supervisors will have as difficult a time implementing the Solvency II directive as the insurance companies.
Compliance of functions with regulations Serbian insurers show considerable confidence in their management systems’ compliance with Solvency II regulation. They are particularly confident regarding their actuarial and risk management functions. There are some doubts in relation to the interaction of the various control functions and communication transparency, where only 45% and 38% of respondents respectively are confident (See Figure 12).
Figure 12: “How confident are you that your management systems are in the compliance with Solvency II regulation?”
Source: Authors calculation
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Data Management Data quality and lack of historical data are insurers’ main data management challenges (see Figure 13). Data quality will be crucial to getting an internal model approved for those companies that choose this route. Companies will have to demonstrate that they have achieved the required quality level, and if not they will have to improve it or explain why they have not met the set standards. Companies that opt for the standard formula will also have to meet data quality requirements.
All data used by companies when calculating capital adequacy must be accurate, complete, and relevant. Insurers will accomplish this mostly through IT, actuarial, and financial functions. Insurers in Serbia will have to introduce new methods for assessing data quality and implement new data collection and management software.
Figure 13: “What are considered the key challenges for data gathering and management?”
Other
Lack of ducumented procedure for data management No answer
Lack of common terminology High Very high Lack of historical data Critical Bad data quality
0% 10% 20% 30% 40% 50% 60%
Source: Authors’ calculation
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Figure 14: “What are the most difficult requirements under Pillar 3?”
Source: Authors calculation
Requirements under Pillar 3 In regards to the most difficult requirements under Pillar 3, insurers find all reporting under Pillar 3 equally difficult and challenging, but the solvency and financial condition report (SFCR) is most demanding (see Figure 14).
Mergers and Acquisitions The survey shows that only 13% of respondents do not believe that Solvency II will take them in the direction of mergers and acquisitions. Thirty-four per cent of the market did not answer the question, and 33% of respondents are considering mergers and acquisitions.
5. CONCLUDING REMARKS
Both local and global insurance markets face strong competition because there are many insurance companies. In order to maximize their performance they are forced to offer as many insurance products as possible at lower prices. Therefore they must be familiar with the characteristics, type, and extent of possible risks, and meet the needs of a broader market segment. To achieve
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these goals and to remain profitable it is necessary to have appropriate insurance risk management.
Until now, insurance companies in Serbia have not been under pressure to apply an official risk management framework. In Serbia, depositing guarantee reserves and investing in technical provision is limited to investment portfolios, and exposure to market risk is not included in the calculation of the solvency margin. Therefore, successful insurance companies have to hold a large amount of MCR to cover technical provision, which means larger premiums. Some of the advantages that the introduction of the regulation will bring to insurers are advanced reaction to risks, i.e., better risk management; achieving competitive advantage; and improvement of operational processes. These advantages can increase product profitability and decrease organizational costs. Only a small segment of the market recognizes the potential of the regulation to improve decision-making, as well as to achieve a more efficient and effective use of capital and improve credit ratings.
Insurers in Serbia believe that Solvency II regulation will improve the existing structure of their company and its current business model. They do not expect a change in management structure, but they do expect moderate changes in the work of the board. Solvency II regulation will introduce changes in the way almost all sectors work. The biggest changes are expected in the risk sector, the financial sector, internal audit, and the actuarial sector.
Most Serbian insurance companies say they have neither adequate processes nor adequate tools to meet the requirements of the directive. This indicates the magnitude of changes expected in the current mode of operation. Most of the market will require reorganization and restructuring at the level of the entire company. First, there will be significant changes in the risk sector because new techniques for risk mitigation will have to be introduced. Second, investment strategies will have to change to meet capital requirements related to different asset classes. Likewise, significant changes are expected in the current product mix, and existing products will have to be redesigned.
The top five areas that insurance companies in Serbia must focus on to comply with the regulation are creating internal models and Own Risk and Solvency Assessment (ORSA), risk measurement, risk management systems, data quality and data infrastructure, and data management processes. ORSA is an important part of Solvency II, as it is an opportunity for companies to demonstrate that
188 SURVEY OF THE READINESS OF INSURANCE COMPANIES IN SERBIA FOR SOLVENCY II they really understand their own risks. They can use this knowledge and incorporate it in the decision-making process, which should make for more efficient management of their business. Appetite for risk is another key focus of all respondents, given that the directive will force insurers to articulate their behaviour in accordance with the risk they hold.
Solvency II requires using an elaborate risk management framework at the level of the entire organization. This means a complete turnaround for insurance company processes, people, knowledge, and information structure in order to achieve proper organization and processes, methods of evaluation, and reporting procedures. To evaluate assets and liabilities, calculate capital, and ultimately establish a risk management framework it is necessary to thoroughly analyse and improve data structure and storage and to develop accessible information systems and technology. This can be a significant financial pressure, but it will eventually enable the creation of a platform for obtaining timely, reliable, and accurate information for proper decision-making. As regards the issue of data management, data quality and lack of historical data have proven to be significant challenges for Serbian insurers. Poor data quality and lack of documented procedures for data collection and management are a huge problem. Ignorance of the data required for Solvency II is only the first stage.
Since the introduction of the regulation, insurer’s expectations in terms of business benefits have been mainly positive. A small percentage of the market does not believe that the introduction of the regulation will produce any business benefits other than just compliance with the regulation. Insurers expect the greatest business benefits to come through improved risk management, better understanding of risk, better allocation of capital, and through the ORSA process. Some companies recognize that successful implementation offers the opportunity to gain a better competitive position. Companies that do not recognize the benefits of Solvency II may miss the opportunity to gain strategic value from significant investments realized while implementing the regulation.
However, regardless of the business benefits to be gained from Solvency II, operating expenses are expected to increase as a result of introducing the regulation. These expenses are mostly in IT sector infrastructure and the implementation of risk and solvency self-assessment. Management restructuring is also considered a major cost driver when implementing Solvency II. Employing experts and educating employees are the next most
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expensive, followed by internal and external reporting and the risk management programme.
The clarity of the Solvency II Directive is a problematic area. This concern is particularly acute among businesses that have not yet launched the project. Developing an internal model and calculating capital adequacy using the standard formula are considered a challenge by all insurers, which is specifically connected to insufficient understanding of Solvency II.
Most insurance companies in Serbia will decide to use the standard formula to calculate capital adequacy. Few companies have the capacity to develop an internal model, as it is very expensive. Thus, only companies that are part of a group will be able to develop their own internal model. However, an internal model offers certain benefits: since it is designed to reflect an insurer's unique risk profile it is more likely that the insurance company will get an SCR that more closely reflects actual risk than with the standard formula, which can ultimately lead to holding a lower amount of necessary capital.
Communication between companies and supervisors appears to be insufficient and needs to be improved. Insurers’ lack of confidence in supervisors is unsurprising when only 39% of insurers consider developing and using a full or partial internal model when Solvency II comes into effect. Companies must have a better understanding of their ability to use internal models, because this is fundamental to their implementation plans. This means their ability to achieve adequate internal models as well as the ability of supervisors to review and approve these designs.
Pillar 3 relates to prudential reporting using common European reports and public disclosure of financial conditions and solvency reports. Pillar 3 has a key role in the Solvency II regime by ensuring greater transparency of insurers’ operations. All reporting under Pillar 3 is difficult and challenging for Serbian insurers, and the report on solvency and financial conditions (SFCR) is the most demanding. This is to be expected, given that the reports a company has to prepare under the Solvency II Directive differ significantly from those under the current regime, regarding both the terms and the frequency of reporting. The biggest challenges for insurers are the very detailed information required by these reports, the unstable final version of the given templates, and the human resources needed to meet these requirements.
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Solvency II is considered an important catalyst that motivates insurers to review their corporate structure and create more efficient tax, capital, and organizational structures. Consequently, a third of the Serbian insurance market is considering mergers and acquisitions if the right opportunity arises.
The entry of foreign capital into the domestic insurance market is significant for the development of insurance in Serbia: it improves the business development of the entire insurance sector through better corporate governance, increased transparency, greater competition, and the introduction of new products. However, the regulatory framework in Serbia is far behind that implemented in the EU market. Given that Serbia aspires to join the EU, in the coming period it will have to harmonize its regulatory framework with that in Europe.
The Solvency II project is expected to bring significant benefits, and a positive impact on all stakeholders including insurers, supervisors, insurance policy- holders, and the economy in general. The direct beneficiaries of Solvency II will be the insurers. In addition to promoting sound risk management, aligning supervisory requirements with market practices, and rewarding well-managed companies, Solvency II will contribute to further integration of the European Union insurance market. The international competitiveness of EU insurers and reinsurers will be improved through the alignment of regulatory quantitative requirements with the true economic cost of risks run. Supervisors will have better control over insurance operations, thus enabling more timely and effective action, as well as powers to conduct comprehensive assessments of all the risks that insurers face. The cooperation and convergence of supervisors will also be enhanced.
The analysis of the results obtained by the questionnaire from Serbian insurers demonstrates that preparations for implementing the new solvency regime are at a very low level, in contrast to insurers in the EU. A small percentage of the market has progressed sufficiently to specifically consider the strategic impact of the regulation, but none of the companies operating in Serbia has progressed enough to cover all three pillars prescribed by Solvency II regulation. Thus, there is reasonable doubt that the Serbian insurance market will be able to comply with the regulation when required.
One thing is certain: a complete reorganization of the entire Serbian insurance sector can be expected as a result of adopting Solvency II regulation, and implementing European regulation will certainly be more difficult than it was in
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the EU market, given the small size and scope of Serbian insurance companies, and the unpreparedness of insurance supervision to adopt new working methods.
REFERENCES
Abdullah, Maryam, Marios Argyrou, Naiterprit Hanspal, and George Orros (2012). Embedding Solvency II into Business as Usual for General Insurance. GIRO Conference and Exhibition.
Bragt, David, Hens Steehouwer, and Bart Waalwijk (2010). Market-Consistent ALM for Life Insurers – Steps toward Solvency II. The Geneva Papers, doi:10.1057, 92-109.
Cannizzo, L., and Vora, K. (2011). Impact of Solvency II on Lloyd’s of London – Implications for the Management of Insurance Assets. Payden & Rygel Global Limited, Financial Services Authority, London, working paper.
Hernández Solís, M., Herrador Alcaide, T. (2014). Application of Solvency II from EU Directive to Spanish life insurance industry. Anales del Instituto de Actuarios Españoles, 3ª época, 20, 2014/1- 16.
Holzmüller, I. (2009). The United States RBC Standards, Solvency II and the Swiss Solvency Test: A Comparative Assessment. The Geneva Papers, doi:10.1057.
Höring, D. (2012). Will Solvency II Market Risk Requirements Bite? The Impact of Solvency II on Insurers’ Asset Allocation. The Geneva Papers, doi:10.1057/gpp.2012.31.
Rossum, A., (2005). Regulation and Insurance Economics. The Geneva Papers on Risk and Insurance - Issues and Practice, doi:10.1057.
Impavido, G., Al-darwish, A., Hafeman, M., Kemp, M., and O’Malley, P. (2011). Possible Unintended Consequences of Basel III and Solvency II. IMF Working Papers, No. 11/187, pp. 1-70.
Stoyanova, R., Gründl, H. (2014). Solvency II: A Driver for Mergers and Acquisitions? The Geneva Papers, doi:10.1057/gpp.2013.32.
Deloitte, (2010). Solvency II Survey 2010, Counting down to the Directive. http://www. economistinsights.com/sites/default/files/SolvencyII_2010_%20FINAL.pdf, April 2016.
Deloitte, (2012). Solvency II Survey 2012 Where are insurers heading? http://www.slideshare.net/ Management-Thinking/solvency-ii-survey-2012-where-are-insurers-heading, March 2014.
Deloitte, (2013). Gaining momentum, Insurers’ preparations for the new IFRS accounting rules. http://www2.deloitte.com, April 2016.
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Deloitte, (2013). Setting a higher bar. Global risk management survey, eighth edition. http://www2. deloitte.com, April 2016.
Deloitte, (2015). Solvency II Pillar 3. http://www2.deloitte.com, April 2016.
Deloitte, (2016). Capital Management in Insurance Survey 2015. http://www2.deloitte.com, April 2016.
E&Y, (2014). European Solvency II Survey 2014. http://www.ey.com/, January 2015.
E&Y, (2012). How asset managers are preparing for Solvency II, Solvency II for asset management survey findings 2012. http://www.ey.com/, April 2016.
EIOPA, (2011). EIOPA Report on the fifth Quantitative Impact Study (QIS5) for Solvency II. https:// eiopa.europa.eu/Publications/Reports/QIS5_Report_Final.pdf, April 2016.
KPMG, (2012). Solvency II Readiness Survey in Central and Eastern Europe. http://www.kpmg. com/, March 2014.
KPMG, (2015). Swiss ORSA Survey Results Report. www.kpmg.ch, April 2016.
KPMG, (2015). Solvency II Exposed. www.kpmg.com, April 2016.
National Bank of Serbia (2014). Insurance sector in Serbia – Report for III trimester of 2014. http:// www.nbs.rs/internet/english/60/60_2/index.html, December, 2014.
PWC (2010) Getting Set for Solvency II. http://www.pwc.co.uk/insurance/publications/solvency-ii- publications.jhtml, March 2014
PwC (2014). Solvency II Risk Capital Survey: Stand out for the right reasons. www.pwc.com, April 2016.
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Received: May 4, 2017 Accepted: December 4, 2017
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APPENDIX
Questionnaire on the readiness of the largest insurance companies operating in Serbia to implement Solvency II.
1. How confident are you that the Serbian insurance market will be able to carry out compliance with the Solvency II regulation when required? (Please mark X next to the right answer) o Not confident at all o Very concerned o Concerned o Confident o Very confident o No answer 2. Do you think you will be able to adjust yours operations to the new regime in a timely manner? (Please mark X next to the right answer) o Yes o No o Not sure And have you started preparations for the introduction of the Directive? o No, and we are not planning to until the times comes o No, but we have planned it in the next year o Yes, we are considering the strategic impact that the regulation will have o Yes, we are covering all three pillars o Yes, we are covering only certain parts
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3. In your opinion, in which of the following areas of your company business will Solvency II have the greatest strategic impact? (Please mark X in the right field) Yes, Yes, Not No AREA No positive negative considered answer Current business model Existing structure of the company Existing management structure Capital management at the entire company level Capital management and its allocation at the level of the business unit Forms of capital that will be held in the business Management information required to make strategic decisions. Management information required to make everyday decisions. Reports to the supervisors Public reports
4. What are your main objectives in the implementation of Solvency II? (Insert X next to each response which you believe applies) o Compliance with the regulatory demands o Reaction to the expectations of shareholders and investors o Maintenance / improvement of the credit rating o Improving operational processes o Competitive advantage o The possibility of a better response to risk o Efficient and effective use of capital o Improvement in the decision-making process o Organizational rationalization o Improved profitability (product and overall profitability) o Other
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5. Please rank three key factors for implementing the Regulation Factor I II III Managing board’s commitment Senior management’s commitment Understanding of the regulation by the managing board, i.e., senior management Internal resource possibilities and quality Budget/cost control Project management Technology Cooperation between different functions Data quality and availability Clear instructions from supervisors Other
6. What are the functions included (or in your opinion that should be included) in the project Solvency II and what drives them? (In each row enter X in the appropriate box) Included but not Function Main driver Not included main driver Board Risk Actuarial Finance Internal audit External sources
7. If your company is part of a group, how will you perform under Solvency II? (Insert X by the respective response)
o We will perform as a stand-alone entity o We will use the support of our parent company 8. How confident are you that your operational processes and tools will be adequate to meet the requirements of the Directive? (Insert X by the respective response) o Not sure o Very concerned o Concerned o Confident o Very confident
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9. As a result of the implementation of the Solvency II regulation, do you foresee that your organization will need any of these actions? Select the item to which it relates. o Introducing new risk mitigation techniques o Reorganization/Restructuring o Reallocation o Significant change in investment strategy o Change in product pricing o Launching new products o Redesign of existing products o Change in the product mix o Not yet decided o None of the above
10. Which of the following areas of your organization should be most focused in order to harmonize operations with the regulations of Solvency II? (Choose five) o Planning the implementation o Risk management systems o Data infrastructure and processes of managing data o Data quality o Measurement of risk o Performance, measurement o Documentation – building and use o Construction of internal models, self-assessment of risk and solvency (ORSA) o Information for the management o Environment control, technology
11. Have you started employee education, and, if yes, how? (Mark X next to the right answer) o No o Yes, through seminars o Internal education
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12. Identify areas in which Solvency II will require your own resources, resources of the group, or external resources. (In each row enter X in the appropriate box) Resources Own External No Area of the resources resources answer group Market valuation of insurance liabilities Insurance risk Operational risk Credit risk Market risk Internal model Redesign of business processes (according to the management requirements) Framework for risk management IT systems Data collection, quality of data, and other Timing of the implementation Self-assessment of risk and solvency (ORSA) Supervision review process Documentation Market discipline (reporting under Pillar 3) International implementation/group aspect Dialogue/interaction with supervisors Other
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13. Will the new way of business change the way of business of individual sectors of the insurance company, and to what extent? (In each row enter X in the appropriate box) Sector Significant change Mild change No change Board Risk Actuarial Finance Internal audit
14. In which sectors will Solvency II require the engagement of additional professional staff? (In each row enter X in the appropriate box) Internal staff External staff Risk Actuarial Finance IT Other
15. Solvency II requires insurance companies to analyse the risks they face across all company operations and thus to determine the appropriate level of capital to hold. Accordingly, will your company introduce new risk mitigation techniques and do you have a plan for introducing them? (Mark X next to the right answer) o No new risk mitigation techniques will be introduced o Yes, but we don’t have worked-out plan o Yes, we have worked-out plan
16. What do you expect in terms of business benefits from the introduction of Solvency II? (Mark X next to the right answer) o Significant tangible business benefits o Certain tangible business benefits o Unspecified tangible business benefits o No business benefits other than compliance with the regulation
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17. Choose the business benefits that in your opinion your company will accomplish by introducing the Directive: o Better understanding of your own business o Improved framework for risk management o Improved allocation of capital o Improved pricing o Better production strategies o Competitive advantage o None of the above
18. Do you expect an increase in operating expenses as a result of implementing the Directive? (Mark X next to the right answer) o Yes o No o Not sure
19. Where are operating expenses most located? (Rank them according to size with numbers 1, 2, 3.) o Engagement of experts and education of employees o Management restructuring o Development of the internal model o The implementation of self-assessment of risk and solvency (ORSA) o Acceptance of the enterprise risk management programme (ERM) o Internal and external reporting o IT sector infrastructure o General changes in management o Other
20. Which model for the calculation of capital adequacy most suits your organization? (Mark X next to the answer) o Full internal model o Partial internal model o Standard formula
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21. In to your opinion, which areas will be most beneficent? (In each row enter X in the appropriate box) Extremely No Small Significant No Area high benefit Benefit benefit answer benefits Reducing capital requirements / capital incentives Better balance of risk and return of capital Improved capital management More efficient risk- management Interaction with rating agencies Information accessibility Other areas
22. What do you consider as the challenges to implementation? (In each row enter X in the appropriate box) No Significant Very high No Area challenge challenge challenge answer Board engagement Redesign of business process Cost of compliance Internal audit Lack of understanding of Solvency II Risk management – integration and embedding Actuarial – standard formula Actuarial – build, implementation, and review of the internal model Finances – capital modelling Finances – data disclosure
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IT systems – system development, data capture Insurance – risk management, price based on risk Development of new structure according to Solvency II
23. If you opt for a full or partial internal model, how much time will be needed for its construction? (Mark X next to the right answer) o 3 months o 6 months o A year o Over one year
24. The construction of the internal model is required to meet certain conditions. Check in the appropriate box next to the condition according to its current fulfilment. Condition Unfulfilled Partially Fulfilled fulfilled Engaging and gaining internal support Decision whether to develop a centralized or decentralized internal model Reasonable risk appetite (coherent risk framework) Adequate systems and processes for demonstrating the use of internal models Application of proportionality – the approach used in the internal model must be proportional to the size, complexity, and risk of the organization Automation of the system and the improvement of processes and resources to ensure the quality and safety of the internal model data. Communication with shareholders regarding achieved quality
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25. How confident are you that your management systems are in the compliance with Solvency II regulation? (Mark X next to the right answer) o Very confident o Confident o Not sure o Not so confident o Not confident at all
26. How confident are you that your management systems are in the compliance with Solvency II regulation? (Please mark X in the appropriate field) Not Very Not Not so Function Confident confident confident sure confident at all Communication transparency Interaction between different control functions Compliance Internal control framework Actuarial function Risk management Organizational structure Interaction between higher management and key control functions Management board control function
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27. What are considered the key challenges for data gathering and management? Critical High Very high No answer Bad data quality Lack of historical data Lack of common terminology Lack of documented procedure for data management Other
28. How will you assess data quality? (Mark X to the right answer) o New software implementation o Using existing software o We will introduce a new way to assess data quality o We will use the existing way to assess data quality o Assessment by hand o Other
29. What are the most difficult requirements under Pillar 3? o Annual quantity reporting templates (QRT) o Quarterly quantity reporting templates (QRT) o Regular Supervisory Report (RSR) o Solvency and financial condition report (SFCR) o Other
30. Will Solvency II take you in the direction of mergers and acquisitions? (Mark X next to the right answer) o No o Probably – we will take into consideration if the opportunity arises o Yes – we are considering mergers and acquisitions o No answer
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